Mortgage Market in The United States - Case Study Example

Mortgage Market in the United s. INTRODUCTION: The mortgage market in the United s is on a downward slide. This depends on which side the statement is addressed. On the side of the mortgagor (borrower), the decrease in the mortgage interest rates is a welcome and economically good situation. However, this is not a good predicament to be in if the person affected is on the side of the lender (mortgagee). For, he or she will earn lesser and lesser interest income (Malloy 50). The following paragraphs explain the nuances of the mortgage market in the United States. BODY: Risk and term structures of interest rates The article U.S. Economy in a Dangerous Drift stated that the mortgage debt of owners in relation to their income is high based on prior trends. However, the low interest rates offered by mortgage lenders as well as the requirement to service the mortgage debts of the home owners in relation to their higher take home pay will not bring back the sad economic scenario in the 1990s era. Also the high value attached to the homes has triggered the money lenders to enter into the home mortgage and the chattel mortgage economic market. Currently, the fixed costs that goes with maintaining a home is no longer as expensive as the mortgage homes of the early part of the 1990s(2003;p.5). Monetary Policy and Interest rates and Deposit Receiving financial institutions and intermediaries such the the Federal Reserve Bank and other banks Despite the unfortunate beginnings in the latter part of 2002 and until 2003, many people contributed to the economy by continuing their spending spree at moderate speed. This was one of the major factors that prevented the increase in severity of the economic downturn. Thus, government monetary policy theory states that the state must intervene in order to create a competitive economic environment (Roberts,2000;pp 77). In addition, Marshall theorized that people have the normal attitude of preferring to spend instead of saving their money in His Principles of Economics book as " Everyone is aware that the accumulation of wealth is held in check, and the rate of interest so far sustained, by the preference which the great mass of humanity have for the present over deferred gratifications, or, in other words, by their unwillingness to 'wait'"(Keynes, 1936; pp.242) The supply and demand theory states that as the mortgage interest increases, the number of borrower demands will decrease. And, the supply theory states that as the mortgage interest rate increases, the number of mortgage lenders will increase(Graziano, 1987;p129-145). Both theories state meet when the mortgage lenders lower their interest rates in order to attract more borrowers. For, the best mortgage interest rate that will make both the mortgagor borrower and the mortgagee lender happily meet in the middle is the equilibrium rate. In terms of mortgagor purchasing power, the timely increases in the take home pay off household owners as well as the gains in disposable personal income starting June of 2003 countered the ill effects of the consumer's spending spree. As proof, the share of personal consumption on Gross Domestic Products had reached a whopping seventy percent in the year 2004. For clarity, consumer spending is arrived at taking into consideration the increase in real permanent income, fluctuations in market prices and demographic factors(Su, 2005;p10). MORTGAGE RATE GRAPH Under the theory known as Markowitz economic model, the investors, including the mortgage lender, want to maximize expected return from their investments and minimize variances. For variance is synonymous with risk(Culp, 2001;pp.48-113). Thus, the lenders charge higher interest rates for more risky mortgage borrowers. The above graph shows that there are fluctuations in the mortgage interest rates from the period Aug 2, 2007 to Sept 27 2007. The graph shows that the Thirty -year mortgage rates had declined starting in the middle of July. Then decline trendily continued to decline until the middle of September 2007. As it reached it bottom, it then had nothing else to go but up. Thus, the mortgage rates went up by the end of September 2007(Barndt,1994;54). To reiterate, the supply and demand economic theory tells us that if the price of mortgage interests go up, then the demand for mortgage loans would decrease(Wagermann, 1930; pp. 141-145) Further, one theory or explanation is that regulations and government costs imposed on intermediaries make direct flows via money markets competitive. In the graph above, the Federal government of the United States government instituted a decrease in major short term interest rates for many months now. Finally, the federal government lowered the federal interest rate by a half percent on September 18, 2007. Economically, a bank that has excess money can deposit such amount with the Federal Reserve Bank. This depositor bank can either choose to lend the money or else let the idle cash sleep tight inside the Federal Reserve Bank without earning mortgage interest income. Other banks can borrow money from the Federal Reserve bank and pay a discount interest rate for the service. As of August, 2007, the Federal Reserve Bank had lowered the discount rate to by as much as a half percent. The decline in the United States dollar would also trigger the foreign investments in the United States. The foreign investments would seeming decline in the areas of stocks, real estate and bonds if the U.S. dollar value drops as compared with the European Union currency -Euro because the foreign investors in Wall street would generate lesser interest income, yield and earnings per share. Thus the foreign investors, like the Europeans, would divert their invested from the United States stock market, mortgage investments and others to companies outside the United States. For, economically, the other countries will generate higher income than if the investments funneled into the United States. Thus, the Federal Reserve Bank comes to the rescue of the United States territory with its lowering of interest rates. Also, one economic theory states that it is a better alternative for someone to invest his or her money in two or more investment schemes in order to smooth out the bumps for a smooth travel. In terms of fluctuations in mortgage interest payments out the inevitable shifts in the prices of individual stocks or mortgage instruments in order to diffuse or lessen the ill -effects of investing with only one backmortgage interest price fluctuations and other price fluctuations. For, the portfolio theory states that a rise in the value of stocks in another company or two can more than offset losses in another company. (Murphy, 2000; pp. 10-65). Mortgage Graph (Annual) The above graph shows the unpredictability of the mortgage interest rates in the United States Market for the preceding one year period ending September 27, 2007. Thus, the drop in the value of the United States dollars results to a decrease in travel outside the United States because traveling has now become a luxury and not a leisure activity. Also, the cost of imported goods will now increase when the value of the United States Dollar drops. On the other hand, many foreigners can now afford to visit the United States with the decline in the U.S. dollar value. This increase in the influx of tourist into the United States will spur the United States economy. Likewise, foreign countries can now afford to buy United States goods with the lowering of the U.S. dollar value. Thus, the United States exports will increase. An increase in the United States exports will increase the economy of the United States. This will now deter or decrease the effects of a threatening recession that is knocking at the entrance doors of United States families. In relation to the mortgage market, the drop in the short term interest rates by the Federal Reserve Bank of the United States will bring about the lowering of mortgage interest rates resulting to a lowering of mortgage interest rate indexes. Also, the decrease in the short term interest rates on September 18, 2007 triggered an increase in the thirty -year fixed rate loans by about one eight percent. The effect of the decrease in interest rates on short term borrowings have little effect on long term borrowings because the mortgagee (lender) is locked for many years with a mortgage agreement with the mortgagor (borrower). However, the decrease in short term interest rates will influence the change in long term mortgage interest rates. Meaning, the long term mortgage interest rates will follow suit by also lowering their mortgage interest rates. To reiterate, the banks factor in current and future inflation rates in coming up with the mortgage interest rates(Angel,2000:pp.100 -105). To fix the economic slowdown, banks and mortgage companies must nail their interest rate on short term mortgage loans so that there will be lessened fluctuations in the interest rate markets. It seems that the current economic slowdown that is engulfing the entire United States and caused the devaluation of its currency in relation to the Euro dollar and other monies will dig in for a long time to come. Short and long-term debt markets Most mortgage lenders have invested their money in refinancing during the refinance boom. They had employed so many people and also increase their refinancing of mortgage loans. However, this economic activity has now come to a grinding slowdown resulting to a downward trend. To bounce back, some resourceful mortgage lenders were successful because they increased their mortgage investments in the economy. The mortgage lenders also increased the speed in investing in the mortgage market thus getting the prime customers first. As the saying goes "the early bird catches the worm". The few successful mortgage lenders innovated their economic marketing strategy by DIVERSIFYING. They correctly put their money in a portfolio. A portfolio consists of more two or more different and varied investments. Their success was influenced by their speed in winning new customers in the mortgage market in blinding speed thereby outpacing and outgunning their competitors in the tight U.S. mortgage market. Also, the successful mortgage lenders hedged their investment in the mortgage market on other funds in order to ensure that any losses from the mortgage economy will be offset, reduced or even eliminated. The saying "do not put all your eggs in the same basket" applies here(Peterson, 2007;p.54). In addition, another theory states that the SR instrument is invariably a discount instrument. The lender (or discounter) purchases the instrument from the borrower at a discount of the face value of the instrument, so that the rate of return is determined by the difference between the discounted price and face value paid at maturity. In addition, residential investment hit its boom in the early 2000 period. There was a big increase in the construction of homes in the early 2000s. This was the effect of low interest rates that the mortgage lenders offered to families wanting to build their dream homes. The investment in mortgage loans was precipitated by the equity market bubble, the low return gained from interest bearing investment alternatives plus the robustly increasing rise in house values had successfully courted people to put their hard earned money in the real estate markets(Su, 2005;p10). Equity markets Investments in the equity market are sometimes better than venturing into the economical dangers of mortgage lending. For, investment in equity means buying shares o f stocks in another company. The person owning will become part OWNERS of the company the invest their money in. And, these new mortgage lenders turned stock owners can now earn in two days as compared to a mortgage deal. The stock owner can sell his or her shares to the stock market or elsewhere at a higher price than the amount he or she paid when investing in the stocks. Second, the stock owner investor will earn by receiving cash dividends as well as stock dividends using the earnings per -share formula(Chisolm,1981;pp. 241-245). On the other hand, the stock market crash on Black Saturday, October 24, 1929 in the New York Stock Exchange is a sad and awakening reminder to the entire world that investments in stocks is not always a sure winner. The stock market during the Crash had fallen by 34 points representing a whopping nine percent drop in the entire stock market. Thus, there were huge volumes of stock transfers for the remaining nine months of 1929. The stockholders panicked resulting to an unabated stock market selling spree. Economics tells us that the stock prices will evidently decrease if the number of sellers in the stock market increases (Bierman, 1998; pp. 1). Yield and other Financial Data. Many Mortgage lending companies are doing well in their economic sphere . First, Municipal Mortgage & Equity, LLC generated a stock market price high of $32.40 per share for the past 52 weeks of operation, its beta is good at .30 and its earnings per share of stock is $2.05, its yield is $ 9.12 its outstanding shares of stock are 38.43 million, its dividend payment was .52 per share of stock, its price earnings ratio is 11.16, . Also, Thornburg Mortgage, Inc. had a 52 week high stock price of $28.40 as of Oct 5, 2007, its dividend payment is $.68 per share, its Yield was $20.27, Its outstanding shares of stock was 122.86 million shares, its beta is also good at .55 and its earnings per share is $2.59. In addition, Morton's Restaurant. Table 1 Mortgage Interest Rate Forecast Sep 2007 Oct 2007 Nov 2007 Dec 2007 Jan 2008 Feb 2008 Forecast Value 6.49 6.45 6.41 6.40 6.33 6.35 50% Correct 0.16 0.19 0.22 0.24 0.25 0.27 80% Correct 0.26 0.32 0.36 0.39 0.42 0.44 Furthermore, a graph of a 30 year Conventional FHLMC Contract Rate Percent average of Month Mortgage Interest Rate based on past years shows that the trend is for the mortgage interest rates to continue its downward course unless external factors will influence the future to take another unpredictable mortgage interest rate path. For, the above shows that the September 2007 forecast value of 6.49 percent will go down to 6.41 in November 2007 and finally will decrease to $ 6.35 in Feb 2008. Thus, the mortgage companies will earn lesser interest income from the above Graph 3 30 Year Conventional Mortgage Interest Rate Past Trend Present Value & Future Forecasted Values The above graph shows the above graph shows a thirty year conventional Mortgage Interest Rate graph based on the Past Trend Present Value & Future Projection. Since the supplier (mortgage lending company wants to increase its customer base, it offers the REF: http://www.forecasts.org/data/data/MORTG.htm CONCLUSION: The theories delineated in this course have been applied to the above discussion on the topic of financial instability caused by the weakness of the sub -prime mortgage market in the U.S. The theories show that the volatility of the mortgage market is in some way unpredictable. However, by using the graph and technical analysis, the projection or forecast of future mortgage interest rates can be better estimated. Also, the federal reserve bank and other financial intermediaries between the money lender (mortgagee) and the borrower (mortgagor) have an important part to play in order to keep the mortgage lending companies as well as the people who borrow money from the mortgagees profitably happy. In conclusion, even the mortgage interest rates OBEY the supply and demand principles of Economics. For, the theories delineated above account or explain the financial instability caused by the weakness of the sub-prime mortgage market in the U.S. REFERENCES Peterson, James R.(2003) "Tips for Success in the Secondary Market: Two Keys Getting More Home Loans to Market Faster and Managing Fallout." ABA Banking Journal 95.10: P.54 Chisolm, R., McCarty, M., (1981) "Principles of Economics", London, Scott Foresman,.pp. 241-245 Bierman, H., (1998) The Causes of the 1929 Stock Market Crash: A Speculative Orgy or a New Era, Westport, C.T., Greenwood Press; P. 1 Su, B., 2005, The U.S. Economy to 2014: The Economy is Expected to Expand at a Steady Pace over the Coming Decade, While Inflation Will Remain Restrained and Productivity Growth Will Remain Strong, Monthly Labor Review, Vol. 128 Issue 11, U.S. Bureau of Labor Statistics; p. 10 No author, 2003, U.S. Economy in a Dangerous Drift, Canadian Speeches, Vol. 17, Issue 1, March 2003, Gale Press Angel, S., (2000) Housing Policy Matters: A Global Analysis, Oxford, Oxford Press; pp. 100-105 Malloy, R., (2000) Law and Market Economy: Reinterpreting the Values of Law and Economics, Cambridge, Cambridge Press; pp. 50 -55) Barndt, W., (1994) User- directed Competitive Intelligence: Closing the Gap Between Supply and Demand, Westport, Quorum Books; pp. 54-58 Keynes, J. Maynard, (1936) The General Theory of Employment, Interest and Money, N.Y., Harcourt Brace; pp. 242 Murphy, a., (2000), Scientific Investment Analysis, Westport, London; pp. 10-65 Wagermann, E.,(1930), Economic Rhythm: a Theory of Business Cycles, N.Y., McGrawHill; p 141. Culp, 2001, (2001), The Risk Management Process: Business Strategy & Tactics, N.Y., Wiley;pp.48-113) Graziano, L., (1987), Interpreting the Money Supply: Human and Institutional Factors ;p. 129-145) Gouldson, A., (2000), Integrating Environment and Economy: Strategies for Local and Regional Government, London, Routledge; pp. 77-78 Realestateabc.com Retrieved October 7, 2007. Forecasts, retrieved Oct 5, 2007 APPENDIX Appendix A Municipal Mortgage & Equity, LLC stock price chart REF: http://finance.google.com/financeq=NYSE%3AMMA Appendix B Thornburg Mortgage, Inc. Read More